Valuing intangible assets no small task

Amid the flurry of acquisition activity that took place during the fourth quarter of 2012, the focus of many advisers, executives and deal teams was getting transactions done before the clock struck midnight on Dec. 31. Now that the dust has begun to settle, a critical issue that must be addressed before these companies' financial statements can be issued is the accounting for these acquisitions.

When an acquisition occurs, Generally Accepted Accounting Principles (GAAP) requires that the value of the newly acquired company's intangible assets be determined and presented at fair value on the acquirer's balance sheet. However, it is often much more difficult, and a much more involved process, to determine the value of an acquired company's intangible assets compared to determining the value of its tangible assets.

For tangible assets, such as cash, accounts receivable and prepaid expenses, it is relatively simple to determine their fair value. Things get a little more complicated when dealing with intangible assets since we cannot simply point to a bank statement or general ledger balance to determine their value as of the transaction date.

Therefore, the first step in valuing an acquired company's intangible assets is determining what intangibles may be present. Gone are the days when all of the purchase price in excess of a target company's net tangible assets in an acquisition could be allocated to “goodwill” — this amount must now first be allocated to specifically identifiable intangible assets with only the remaining residual balance allocated to goodwill. Some of the most commonly recorded intangibles assets include:

Customer relationships: Most companies have repeat customers that continue to return time and time again for goods or services. To the extent that these customers can be identified, the customer relationships have intangible value since the purchaser can expect the customers to continue to do business with the acquired company after the deal has closed.

Trademarks: Trademarks include registered trademarks, trade names and related items that identify a company. The existence of a well known trademark may cause a person to purchase a particular item, which generates cash flow for the company providing the good or service.

Noncompetition agreements: A noncompetition agreement forces key employees to refrain from competing against the newly purchased company, which protects the revenue and margins of the company from the dilution that could have resulted from the competition of those key persons.

Technology: While technology often results in the creation of tangible products, a company's technological know-how is another commonly recorded intangible asset. This intangible asset allows a company to offer products or services that meet or create customer demand.

Valuing intangible assets can be a complicated process that many companies do not have the in-house expertise to tackle on their own, so be sure to bring your auditors and accountants up to speed on any acquisitions made by your company as soon as possible so that you can create a game plan as to how any accounting issues will be addressed. This will allow you to begin the planning process of what documentation will be necessary to support the value of the acquired company's intangible assets and whether it will be necessary to obtain a third-party valuation analysis.

Sean Saari is a senior manager in Skoda Minotti's Valuation and Litigation Advisory Services group. He focuses his practice in the areas of valuation, litigation advisory services, complex damages analysis and modeling, mergers and acquisitions, and strategic planning.